CHAPTER 4

DEPRECIATION
Depreciation is the decrease in value of physical properties with the passage of time and use. More
specifically, depreciation is an accounting concept that establishes an annual deduction against
before-tax income such that the effect of time and use on an asset’s value can be reflected in a firm’s
financial statements.
Depreciation is defined in its accounting sense, as the systematic allocation of the cost of a capital
asset over its useful life. Book value is defined as the original cost of an asset, minus the accumulated
depreciation of the asset.
As depreciation affects income taxes, it should be considered properly when making after-tax
engineering economy studies. In general, property is depreciable if it meets following requirements:
1. It must be used in business or held to produce income.
2. It must have a determinable useful life, and the life must be longer than one year.
3. It must be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural
causes.
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4. It is not inventory, stock in trade, or investment property.
Depreciable property is classified as either tangible or intangible.
❑ Tangible property can be seen or touched, and it includes two main types called
➢ Personal property that includes assets such as machinery, vehicles, equipment, furniture, etc..
➢ Real property is land and generally anything that is erected on, growing on, or attached to land. Land
itself, however, is not depreciable, because it does not have a determinable life.
❑ Intangible property is personal property such as a copyright, patent, or franchise.
Depreciation of this type of assets will not be discussed because engineering projects rarely include this
class of property.
4.1 Kinds of Depreciation
There are two major causes of depreciation:
❑ Physical depreciation:
Is related to an asset’s deterioration and wear over a period of time
❑ Functional depreciation:
It arises from obsolescence of inadequacy of the asset to perform efficiently. Obsolescence may
arises from no further demand for the product that the depreciable asset produces or the availability
of a new depreciable asset that can perform the same function for substantially less cost.
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 ❑Technological depreciation:
Newly developed means of accomplishing a function may make the present means uneconomical .
❑ Depletion:
Consumption of an exhaustible natural resource to produce products or services is termed depletion.
❑ Monetary depreciation:
The change in price levels cause decreas in the value of depreciation reserves.
4.2. Depreciation Methods and Related Time Periods
❑ Straight-Line Method (SL)
❑ Sum-of-the-Years Digits (SYD)
❑ Double Declining-Balance (DDB)
These methods, collectively, will be referred as the classical, or historical,(Before 1981)
❑ Accelerated Cost Recovery System (ACRS) (1981-1987)
❑ Modified Accelerated Cost Recovery System (MACRS) (After 1986)
In this chapter the classical, or historical methods will be discussed. To compute a depreciation charte, three
items are considered: 1. Cost of the property, P
2. Depreciable life in years, N
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3. Salvage Lecture
value 7
of the property at the end 12/11/2020
of its depreciable3 life, S.
4.3 Straight–Line Method (S.L)
Is the simplest to apply and the most widely used of the depreciation methods.
B.V. Book value of the equipment
N Equipment service life
S Salvage value
Depreciation Charge
𝟏
𝑫𝑪 = 𝑷−𝑺
𝑵
Total Depreciation
𝟏
𝑻𝒐𝒕𝒂𝒍 𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 (𝒏) = 𝑷−𝑺
𝑵
Book Value (B.V.(n))
𝑩. 𝑽. 𝒏 = 𝑷 − 𝑻𝒐𝒕𝒂𝒍 𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 (𝒏)
𝒏
𝑩. 𝑽. 𝒏 = 𝑷 − 𝑷−𝑺
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𝑵 Lecture 7 12/11/2020 4
4.4 Sum-of-Year’s Digits Method
This method provides a larger depreciation charge during early years of ownership than in the
later years. The name is taken from the calculation procedures. The annual depreciation charge is
the ratio of the digit representing the remaining years of life 𝑁 − 𝑛 + 1 to the sum of the digits
of the entire service life 1 + 2 + 3 + ⋯ . + 𝑁 − 1 + 𝑁 multiplied by the value 𝑃 − 𝑆 .
Depreciation Charge
𝑵−𝒏+𝟏
𝑫𝑪 𝒏 = 𝑷−𝑺
𝟏 + 𝟐 + 𝟑 + ⋯ . +𝑵
𝟐 𝑵−𝒏+𝟏
𝑫𝑪 𝒏 = 𝑷−𝑺
𝑵 𝑵+𝟏
Total Depreciation
Total depreciation (n)=DC(1)+DC(2) +….. +DC(n)
Book Value (B.V.(n))
𝑩. 𝑽. 𝒏 = 𝑷 − 𝑻𝒐𝒕𝒂𝒍 𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 (𝒏)
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4.5 Double-Declining Balance Method
It is based on the same principle as previous method, that it provides a larger depreciation charge
during early years of ownership than in the later years. It recognizes that changing technologies
make some equipment lose service value rapidly. Thus it is realistic to allocate more to
depreciation in current years than in future years. The name is taken from the calculation
2 1
procedures. Double means that the factor is instead of for the straight line and the
𝑁 𝑁
declining balance is the 𝐵. 𝑉. 𝑛 , so,
Depreciation Charge
𝟐
𝑫𝑫𝑩 𝒏 = 𝑩. 𝑽. 𝒏 − 𝟏
𝑵
Total Depreciation
Total depreciation (n)=DDB(1)+DDB(2) +…. +DDB(n)
Book Value (B.V.(n))
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𝑩. 𝑽. 𝒏 = 𝑷 − 𝑻𝒐𝒕𝒂𝒍 𝒅𝒆𝒑𝒓𝒆𝒄𝒊𝒂𝒕𝒊𝒐𝒏 (𝒏)
Note:
Both straight–line and sum-of-year’s digits depreciation charts are committed to pass with both (0,0)
and (N,S), while Double Declining Balance Chart is committed to pass with (0,0) only. So, there are 3
possibilities as shown in the following figure:

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4.6 Methodology of Solution
Depreciation problem can be solved using a table as shown
Year Depreciation Charge Total Depreciation (n) Book Value (n)
0
1
2

All the required can be obtained from the table

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EXAMPLE 4.1
A piece of construction machinery costs $5,000 and has an anticipated $500 salvage value at the end
of its five-year depreciable life. Compute the depreciation schedule for the machinery by:
(a) Straight line depreciation;
(b) Sum-of-years-digits depreciation;
(c) Double declining balance depreciation.
Solution
𝑷=$5,000 , S= $500 , N= 5 years Year Dc ($) Total Dep. (n) ($) B.V.(n) ($)
(a) Straight line depreciation 0 0 0 5000
𝟏 1 900 900 4100
𝑫𝑪 = 𝑷 − 𝑺 = $900
𝑵 2 900 1800 3200
3 900 2700 2300
4 900 3600 1400
5 900 4500 500
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(b) Sum-of-years-digits depreciation
𝟐 𝑵−𝒏+𝟏
𝑫𝑪 𝒏 = 𝑷−𝑺
𝑵 𝑵+𝟏
𝟐 𝟓−𝒏+𝟏
𝑫𝑪 𝒏 = 𝟓𝟎𝟎𝟎 − 𝟓𝟎𝟎
𝟓×𝟔
𝑫𝑪 𝒏 = 𝟑𝟎𝟎(𝟔 − 𝒏)
Year DC(n) ($) Total Dep.(n) ($) B.V.(n) ($)
0 0 0 5000
1 1500 1500 3500
2 1200 2700 2300
3 900 3600 1400
4 600 4200 800
5 300 4500 500

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(c) Double declining balance depreciation
𝟐
𝑫𝑫𝑩 𝒏 = 𝑩. 𝑽. 𝒏 − 𝟏
𝑵
Year DDB(n) ($) Total Depreciation (n) ($) B.V.(n) ($)
0 0 0 5000
1 2000 2000 3000
2 1200 3200 1800
3 720 3920 1080
4 432 4352 648
5 259.2 4611.2 388.8

EXAMPLE 4.2
The initial cost of a machine is 125,000 EGP, and its salvage value is 15,000 EGP by the end of 10
years service life. Calculate the depreciation charts using:
Straight line depreciation;
(b) Sum-of-years-digits depreciation;
(c) Double declining balance depreciation
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Solution
𝑷=125,000 EGP , S= 15000 EGP , N= 10 years
(a) Straight line depreciation
Year DC (EGP) Total Dep.(n) (EGP) B.V.(n) ($)
𝟏
𝑫𝑪 = 𝑷 − 𝑺 = 11,000 EGP 0 0 0 125,000
𝑵
1 11,000 11,000 114,000
2 11,000 22,000 103,000
3 11,000 33,000 92,000
4 11,000 44,000 81,000
5 11,000 55,000 70,000
6 11,000 66,000 59,000
7 11,000 77,000 48,000
8 11,000 88,000 37,000
9 11,000 99,000 26,000
10 11,000 110,000 15,000
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b) Sum-of-years-digits depreciation
𝟐 𝑵−𝒏+𝟏
𝑫𝑪 𝒏 = 𝑷−𝑺
𝑵 𝑵+𝟏
𝟐 𝟏𝟎 − 𝒏 + 𝟏
𝑫𝑪 𝒏 = 𝟏𝟐𝟓𝟎𝟎𝟎 − 𝟏𝟓𝟎𝟎𝟎
𝟏𝟎 × 𝟏𝟏
𝑫𝑪 𝒏 = 𝟐𝟎𝟎𝟎(𝟏𝟏 − 𝒏)
Year DC (EGP) Total Dep.(n) (EGP) B.V.(n) ($)
0 0 0 125,000
1 20,000 20,000 105,000
2 18,000 38,000 87,000
3 16,000 54,000 71,000
4 14,000 68,000 57,000
5 12,000 80,000 45,000
6 10,000 90,000 35,000
7 8,000 98,000 27,000
8 6,000 104,000 21,000
9 4,000 108,000 17,000
10 2,000 110,000 15,000

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c) Double declining balance depreciation
𝟐
𝑫𝑫𝑩 𝒏 = 𝑩. 𝑽. 𝒏 − 𝟏 Year DDB(n) (EGP) Total Depreciation (n) (EGP) B.V.(n) (EGP)
𝑵
0 0 0 125000
1 25,000 25,000 100,000
2 20,000 45,000 80,000
3 16,000 61,000 64,000
4 12,800 73,800 51,200
5 10,240 84,040 40,010
6 8,002 92,042 32,958
7 6591.6 98,633.6 26,366.4
8 5273.28 103906.88 21,093.12
9 4218.624 108,125.504 16874.496
10 3374.8992 111500.4032 13,499.5968

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